Stocks have rebounded over the past few days following some struggles at the start of the month. It looks like the rebound will continue, which sets up a great environment to make options trades.
Our index indicators are giving bullish readings, an upgrade from last week’s short stay at bullish to neutral, thanks to the sharp rally that occurred this past week. A primary result of the rally is that pressure has eased on the index’s 50-day moving average support levels, which are the bull market’s first line of defense. The Dow can now fall back to 15,780, the S&P 500 to 1,770 and the Nasdaq to 3,955 before the current bullish trend is called into question.
Our internal indicators have also improved from a week ago. The Advance/Decline and Cumulative Volume Indexes have returned to bullish territory, although the 200-day Moving Averages Index remains bearish. Also, eight of nine S&P sector funds are bullish, up by one from last week. The lone bearish sector is Utilities, which would be expected given the outlook for higher interest rates.
That outlook was given considerable credence this week when the Fed announced it was going to begin tapering its Treasury bond purchases. That event has been long anticipated by the markets, which was evidenced by the massive stock rally that ensued following the announcement on Wednesday. Over the past few years, tapering fears have caused market selloffs.
However, one sector that is struggling under tapering pressure is long-term Treasury bonds (TLT), also a reflection of a higher interest rate outlook (bond prices move the opposite direction of interest rates). TLT continues to hover just above key support at $102, while continuing to carve out a bearish chart pattern of “lower highs.” As we’ve mentioned, a break below $102 would likely trigger a steady decline to the $96 area, which in turn would raise questions as to how much of a rise in rates can the economy and stock market can withstand.
With our indicators returning to bullish mode, you should return to favoring bullish options trades over bearish ones. That primarily means buying more calls. But as usual, don’t overlook puts, as the potential for rising interest rates is likely to bring about some increased volatility.
I’ve got a call option in a U.S.-based laboratory medical instrument company, PerkinElmer (PKI). PKI plays in a similar space as Bio-Rad Laboratories (BIO), Bruker Corp. (BRKR), CEPHEID (CPHD), Illumina (ILMN) and Waters Corp. (WAT).
My system rates PKI stock as a “powerhouse” with an exceptional short-term outlook. It’s currently trading around $40.50, and I have a near-term target of $43.40. It’s a perfect set-up for a bullish call options trade.
Buy the PKI March 45 Call options at 70 cents or lower. After entry, take profits if the stock price hits $43.40 or the option price hits $1.70. I do not recommend intra-day stop losses but instead prefer to look at the level of where a stock or option closes. Exit if the stock price closes below $39.00 or the option price closes below 40 cents.
Perkin Elmer is expected to provide quarterly earnings at the end of January, but given my three-week maximum holding time for any options trade, we will have exited the position by then. The great thing about options is that they move quickly, and in my 40 years of professional trading I’ve found that if they don’t make the move I expect within three weeks of holding, it becomes less likely that the trade will hit my target.
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